Bankruptcy Alphabet: B is for Borrow

Yesterday, we talked about asking the right people questions about bankruptcy. Today, we’re continuing our discussion and talking about borrowing in the context of bankruptcy. When you feel your financial world crumbling, there is a natural inclination to raise more money. The most common examples of this is borrowing against retirement funds, from family, friends, home equity line, against a children’s college fund or against someone else’s home equity. This is akin to putting a bandage over a wound that requires stitches and pretending that the Band-Aid is a permanent solution. The Band-Aid does nothing to solve the underlying problem and soon, you have to face your financial situation.

So, why is borrowing such a bad idea? Let me count the ways.

You need to retire one day. Chase doesn’t.

Retirement funds have a special status in bankruptcy in that most of the time, we can protect 100% of it. So, by liquidating or borrowing against your retirement funds, you are exchanging dischargeable debt with protected funds. Additionally, if you liquidate your retirement, or borrow against it but fail to repay, such funds are subject to income tax and penalties. Recent taxes are non-dischargeable. And trust me when I say that you don’t want to owe money to Uncle Sam. Lastly, your retirement money is just that – money set aside for retirement. It should not be used to repay credit cards.

Borrowing from friends and family.

In bankruptcy, family and friends are known as “insiders.” Borrowing from insiders can create problems. First, any money you repaid to insiders within last 12 months of filing must be disclosed on your bankruptcy petition. And the trustee can unwind the repayment by demanding the money back from the insider. Having the trustee threaten your family or friend for money you repaid probably won’t make for pleasant dinner conversation. Furthermore, instead of owing money to a Chase (which would be discharged) now, you owe money to your best friend. Lastly, even if you don’t repay any money, the debt to the insider must be disclosed on the bankruptcy petition. Meaning, your friend or family will receive notice of your bankruptcy.

Turning non-secured debt into secured debt.

This is another no-no. Oftentimes, clients will borrow against their home or worse, from their parent’s (or other’s) home to repay their unsecured debt, such as credit cards. It may sound like an attractive offer, with a reduced interest rate bundled into a single loan. But, this is a potential landmine. What happens when the client can’t repay the secured debt? Now, the home is subject to foreclosure!

So, instead of the worst case scenario being a potential lawsuit by credit card, now the client is facing foreclosure of their home or their family member’s home. Even after bankruptcy, liens generally survive. In another words, if you had $50,000 in credit card debt, that debt is discharged in bankruptcy. After the bankruptcy, that is the end of that debt. But let’s suppose, you borrow $50,000 from your home equity loan. Now, even though you won’t be personally liable for the debt after bankruptcy, the home equity lender may be able to foreclose* on your home.

*Sometimes, it’s possible to “strip” and get rid of a second mortgage.